Royal Dutch Shell Group .com

Financial Times: Worrying problem of the shrinking Shell


By Carola Hoyos

Apr 24, 2004


Royal Dutch/Shell's troubles will be far from over even after regulators, criminal investigators and judges finally rule on the many probes and class action lawsuits facing Europe's second-largest energy group after its reserves scandal.


The single most worrying factor for Shell's executives and shareholders is that the group that once ranked as the world's biggest oil company is shrinking.


"Efficient, low-cost replacement of large volumes of oil and natural gas production will remain the group's central challenge," said Thomas Coleman, analyst at Moody's Investor Services, as his became the third ratings agency to strip Shell of its highly prized triple A debt rating.


Finding oil is becoming more difficult for all the energy companies, especially the biggest ones, whose older fields in the North Sea and US Gulf are slowing down and whose vast production volume means they must find more oil than others to grow.


A company that replaces less than 100 per cent of its reserves sends worrying signals to the market that its future revenues are no longer assured because it has fewer oil reserves to draw on.


Shell has been having more trouble than others replacing its reserves over the past five years.


It was in part this pressure that might have led some of the company's executives to book so many of its reserves prematurely, analysts and lawyers concluded.


But the aggressive booking could not continue and Shell has been forced to cut more than 20 per cent of its reserves since January 9, leaving its proved reserves life at little more than 10 years, two years fewer than its weakest competitor.


The reserves reduction also prompted a recalculation of how much Shell spent to find oil, again showing it to be less successful than its peers, having to spend far more per barrel [see graphic].


Neil McMahon, analyst at Sanford Bernstein, the financial services group, said: "They have a monumental challenge in the 2008 time-frame. They have to get the company's portfolio in a position so that it doesn't fall off a cliff."


What he means is that Shell would have to find new reserves that will be ready to be pumped and sold in 2008. It is a venture that must begin now. "There are no more four-year oil fields left, except maybe in Russia," said Mr McMahon.


With less oil left to discover, companies are having to develop trickier projects, such as deposits in deep waters, which take seven to eight years to bear fruit; projects in oil sands, which take 5-6 years; or far-flung natural gas operations in Australia and Latin America that could take from 5-10 years.


The task for Shell, as it vies for these projects against its fierce competitors, would be made far more difficult by the fact that the company's senior management has shrunk from six to three members.


Since the January 9 announcement that reserves were 20 per cent smaller than it had led investors and the SEC to assume, Sir Philip Watts, chairman, has left as have Walter van de Vijver, head of exploration and production, and Judy Boynton, chief financial officer.


Those left would be dealing with investigations launched by the US Securities and Exchange Commission, the Department of Justice and European regulators, as well as the class action lawsuits, some of which accuse them personally.


But the danger of being too preoccupied to meet the challenge lurks at all ranks of the company.


At the board level, members have a huge headhunting job ahead of them but also have the daunting task of making possibly radical changes among their own ranks. Directors would have to decide whether to heed shareholders' calls for a unified board or at least to put in place a system whereby executive board members are more accountable.


In the lower ranks, disillusionment and a sense of confusion - as controls are tightened, reporting lines are shifted and employees are moved around - would make day-to-day business more of a challenge.


One mid-level employee said: "This should be an important enough wake-up call. Things should have to change. Whilst I don't want people to be fired, I would like to see people moved down because they were given promotions for the wrong reasons."


Robin West, chairman of PFC Energy, the Washington-based consultants said: "It would be very difficult to make large new commitments now that they are concentrating on other things."


One of Shell's first key tests might come in what is arguably the world's most critical big oil frontier: Russia.


Bankers said Shell might already be slipping behind in finding a corporate partner there. Though it has in the past shown a keen interest in doing a deal with Russia's Sibneft, it appears ChevronTexaco of the US,and France's Total have overtaken their Anglo-Dutch rival in negotiations with the oil company.


ExxonMobil, the world's largest listed energy group, is said to have its eye on Yukos and BP, Shell's closest competitor, has boosted its reserves and production by signing the first large Russian deal with TNK.


Shell's efforts with Gazprom, Russia's natural gas monopoly, have been frustratingly slow, though analysts do not rule out the possibility that the two would eventually strike a lucrative deal to supply an increasingly gas-strapped Europe.


Elsewhere, Shell has also managed to surprise investors. Last month it secured the first Libyan gas agreement since frosty relations between the North African country and the US began to thaw.


One of Libya's most senior oil officials said after the deal that the management changes at Shell mattered little. "Shell is still Shell."


But oil executives are quietly beginning to acknowledge that much of the world's oil has already been found. The breakthrough many thought would save the industry in the 1990s - when drilling technology improved, allowing the search for oil to move into deeper water - did not materialise: the oil was just not there, at least in the quantities many had hoped.


Increasingly it will be a company's ability to strike deals with governments that have yet to open up their oil fields that will set it apart.


Shell has a good legacy, having beaten BP and ExxonMobil into Saudi Arabia last year. But relationships take years to build, and turmoil in Shell's ranks, or alack of focus, could quickly be exploited by nimble competitors such as Total.


Shell's relationship with its largest customers is also important - and nowhere more so than in the US.


Shell's ability to reduce the outrage it has caused among US regulators and government officials will influence its future success: and this is why the search for a non-executive chairman with experience in the US is so important.


Hugh Collum, retiring chairman of British Nuclear Fuels, is one of the candidates being considered for non-executive chairman, partly because of his experience dealing with angry US government officials and congressional leaders over a nuclear contract whose price had spiralled out of control.


It will be the task of men like Mr Collum and Shell's senior executives to make sure deliberations in the US over the company's reserves scandal go as smoothly as possible. This minimises the risk of losing focus on its fundamental challenge: to find and sell oil and gas.

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